Enhancing India’s capital market advantage

As we noted in our earlier article (‘India must leverage its capital market advantage’, November 5, 2005), there are several areas that need urgent attention if the capital markets are to further contribute to India’s economic development

First, only a few large companies take corporate governance issues seriously enough. That concern needs to be much more broad-based. There is a positive relationship between market valuation and perceptions of quality of governance. Therefore, efforts must be directed at improving perceptions.

Second, the number of companies listed on the stock exchanges may be large — 7,129 companies are listed on the BSE — but market concentration (defined as the share of top 10 companies in the total market capitalisation) is very high, at 36%. The comparative figure for the NYSE is 20%, and for the Nasdaq 30%. The regulators should give thought to rationalisation of listing requirements on the main exchanges (the NSE and the BSE), while providing other platforms for smaller companies. The absence of foreign listings on the NSE and the BSE must also be addressed.

Third, over 50% of the market capitalisation is not available for trading for various reasons, such as large holdings by promoters. The finance minister is correct in urging that a greater proportion of equity of both public and private sector companies should be actively traded on the stock exchanges. The private sector should take his urging seriously.

For public sector companies, the turnover ratio (annual turnover/market capitalisation) in financial year 2004-2005 was only 25%, against 72% for the NSE as a whole and 32% for the BSE. The corresponding ratios for FY 2003-04 for the NYSE, the Nasdaq and the London Stock Exchange were 91%, 248% and 189%, respectively.

To be credible, the government must walk the talk in this area by overriding the objections of some its own ministers and allies, and increase the free float of public sector organisations. It should also actively assist in developing municipal bond markets and encourage the states to borrow in the market. The budgeting and financial information systems of these entities must be reformed if they are to obtain credit ratings.

International practices give considerable weight to the free-float of shares in indices, which forms the basis for foreign institutional investors’ (FIIs) allocation of funds to various markets. FIIs’ net flows is important for India for liquidity reasons, to unlock value of companies and as a competitive spur to domestic institutional investors.

The role of mutual funds in India is relatively limited. In March 2005, their assets were equivalent to less than 10%  of market capitalisation. In this context, it is important for funds to improve their record in the areas of investor education and professionalism.

Fourth, the corporate debt market, which is an important element of any well-developed capital market, is insignificant in India. High administered interest rates on provident funds and small saving schemes, which also enjoy generous tax benefits, result in pre-emption of savings away from the corporate sector towards often unproductive government expenditure.

Fifth, efforts to develop deeper capital markets will need regulatory backing. Occupational pension plans have the potential to provide substantial and sustained contractual savings to India’s capital markets, India is in the demographic gift phase (that is, its share of working age population in the total population will be increasing till around 2045), and this is expected to increase India’s gross domestic savings to nearly 30% of gross domestic product (DGP). Public policies should aim to channelise these savings towards the capital markets for intermediation. The fringe benefits tax (FBT) on employers’ contributions to superannuation funds is inconsistent with this objective. One hopes this will be remedied in Budget 2006.

To enhance India’s capital market advantage and help develop Mumbai as a regional financial centre, concerted efforts are needed from the stock exchanges, regulators, corporations, and the state and central governments. The capabilities and institutional structures required for this exist, but it is equally critical for all concerned to show determination and maintain consistency of policy.

Mukul G Asher is professor of public policy at the National University of Singapore. sppasher@nus.edu.sg Vikram M Sampat is a strategist with a Fortune 500 company.  vikram_ms1@yahoo.com

The views expressed here reflect the personal views of the authors and should not be attributed to their respective organisations